Banking Capital and Operational Risks: Comparative analysis of regulatory approaches for a bank

The nature of operational risk means that although it constitutes a small part of a bank’s risk profile, it includes unexpected events that could potentially cause the collapse of the entire bank. To understand the relationship between economic and regulatory operational risk capital we first examine selected large internationally active banks’ capital disclosures and review the Basel II approaches to allocation of regulatory capital for operational risk. The extreme risk capital model (ERCM) proposed earlier is applied to calculate the operational risk capital of a specific bank using its internal operational loss data over a four-year period and the results are compared to the proposed alternatives. This comparison supports the argument that the extreme risk capital allocation model view point provides an integrated and holistic view of a bank’s operational risk exposure which is especially suitable for risk management at the strategic level.